Small Business

After a Franchisor Files for Bankruptcy

Bennigan's franchisees are still operating, but the uncertainties they face are heightened by cost pressures and the drop in diners' disposable income

What happens to franchisees when a franchisor goes bankrupt? Bennigan's owners are about to find out. The pub-themed casual dining chain filed a Chapter 7 bankruptcy on July 29, meaning it chose to cease operations and liquidate its assets rather than attempt to reorganize under Chapter 11. Bennigan's closed all company-owned locations and announced plans to sell off the assets. The remaining 138 franchisees are still operating, but they face a tough road ahead.

The first challenge for franchisees was to let customers know they were still open after the sudden closure of the corporate restaurants. "We immediately went to local news coverage," says Larry Briski, president of the Bennigan's Franchise Operators Assn. and owner of four Bennigan's in the Chicago area. "Most of our franchisees did the same thing in their local markets."

The collapse of S&A Restaurant Corp., which owned Bennigan's and the Steak and Ale Chain, took franchisees by surprise. S&A is part of Metromedia, a large, privately held conglomerate run by billionaire chairman John Kluge that has had interests in media, energy, and other sectors. Briski says there was no indication the restaurant chain was on the brink of bankruptcy in a meeting with company officials last month. (S&A could not be reached for comment. The company's bankruptcy attorney did not return calls for comment.

Margin Squeeze

The franchisees' supply chain is intact, and Briski expects vendors to honor their contracts. Sales at his restaurants haven't been affected by the bankruptcy. "We're moving forward. We're excited about the brand," he says.

But the outlook for Bennigan's franchisees and others in the casual dining space doesn't look good, analysts say. High food, gas, and labor costs are squeezing the restaurants' margins while leaving consumers with less disposable income to eat out. The predicament follows several years of aggressive expansion by casual dining chains, many of them franchises.

"This marketplace has grown significantly, which means there's a lot of restaurants and a lot of seats and not enough people to fill those seats," says Darren Tristano, executive vice-president of Chicago food industry consultant Technomic. He says the number of casual dining restaurants from major chains has grown at a 7% to 8% year-over-year pace since 2000, while unit growth in the restaurant industry as a whole has been more like 1%.

Supplier Price Hikes?

Tristano says he expects restaurant sales, when adjusted for inflation, to decline in 2008 for the first time since 1990. Chains like Applebee's, Chili's, and Ruby Tuesday (RT) will likely be hit because they haven't differentiated themselves in the eyes of diners who view them as interchangeable, he says.

The uncertainty is heightened for Bennigan's orphaned franchisees. Tristano says suppliers may want to raise prices since they don't have corporate stores to sell to anymore, reducing the economies of scale. The ownership of the trademark and franchising system is in question as well. While Briski reported that the brand had been sold to a company in Atlanta identified as Atalaya Administrative, little information on the new owner was available. A company called Atalaya Capital Management lists offices in New York and Atlanta but could not be reached for comment.

When franchisors file for bankruptcy (BusinessWeek.com, 8/4/08), they often seek protection from creditors while reorganizing. After declaring bankruptcy in 1990, 7-Eleven sold a majority stake in the company to its Japanese affiliate, which retains control of the company today. Other brands are acquired by competitors or buyout firms that hope to resell them for a profit.

Ground Round Coop

In the case of Ground Round, the franchisees themselves formed a cooperative to bid for the brand and the franchise system. The group initially formed to deal with distributors during the bankruptcy process, and eventually decided to bid for the rights to operate the system, says Mike Ludwig, COO of the Ground Round Independent Owners Cooperative. "We set our own royalty rates, we have our own meetings," says Ludwig, who recently closed his own Ground Round in Hadley, Mass., because of rising rents.

The entity still runs the 46 remaining Ground Round franchises, of 72 that were operating when the chain went bankrupt in 2004. The franchisee cooperative is unique, and not without challenges. It has a staff of two, compared with the 45 people who once worked in the corporate office.

But Ludwig suggests the deal was better than some alternatives. One of the bidders for the franchise during Ground Round's bankruptcy was Bennigan's parent, Metromedia.

For a look at what happened when 11 big brands went bankrupt, flip through this slide show. For follow-up on Bennigan's, check out our staff blog.